Bills Digest no. 70 2008–09

WARNING:
This Digest was prepared for debate. It reflects the legislation as
introduced and does not canvass subsequent amendments. This Digest
does not have any official legal status. Other sources should be
consulted to determine the subsequent official status of the
Bill.

The Bill provides a standing
appropriation to pay for any possible claims under the Government s
Guarantee Scheme for Large Deposits and Wholesale Funding (the
Guarantee Scheme). The Bill also enables the Government to borrow
money to pay these claims if the Consolidated Revenue Fund (CRF)
contains insufficient funds at the time claims are made.

It may assist to explain at the outset that the terms large
deposit and wholesale funding are defined in the Explanatory
Memorandum for the Bill as follows:

Large deposit means deposits in excess of $1 million
deposited with an Australian-incorporated ADI [authorised
deposit-taking institution] or any deposits with an Australian
branch of a foreign bank, which may be covered by the Deed of
Guarantee in accordance with Scheme Rules , and

Wholesale funding includes short-term funding and term
funding for up to 60 months provided to financial institutions,
such as ADIs, both within Australia and in overseas markets,
enabling those institutions to provide credit to businesses and
households .[1]

On 12 October 2008, the Prime Minister, the Hon Kevin Rudd MP,
announced
two schemes to guarantee the liabilities of Australia s financial
system in the wake of the current global financial crisis: a bank
deposit guarantee, and a wholesale funding for banks
guarantee.[2]

The first scheme, known as the Financial Claims Scheme (FCS),
was initially designed to cover all deposits held in Australian
authorised deposit-taking institutions (ADIs), including banks,
building societies, credit unions and Australian subsidiaries of
foreign-owned banks.[3] The second scheme, the wholesale funding guarantee, was
designed to provide security for funding provided to Australian
financial institutions by domestic and international sources, by
offering a guarantee on wholesale loans to Australian ADIs for a
fee.

In announcing the schemes on 12 October 2008, the Prime Minister
said:

The Australian financial system is demonstrating its resilience
to the international financial market turbulence. Australia s
banking institutions remain sound, well-capitalised and profitable
with high asset quality.

The Australian financial system is however being affected by
global events. Recent developments in the international wholesale
funding markets have created acute funding pressures that now pose
potential risks to the total supply of finance to the Australian
economy.

This has the potential to slow further domestic economic
activity.

The G-7 [Group of 7 leading economies] met on 10 October and agreed
that the current situation calls for urgent and exceptional action
to stabilise financial markets and restore the flow of credit, to
support global economic growth.[4]

Specifically in relation to the wholesale funding guarantee, the
Prime Minister said:

The Australian Government will also guarantee wholesale term
funding of Australian incorporated banks and other authorised
deposit-taking institutions (ADIs).

The Government will offer the guarantee in return for a fee in
respect of eligible non-deposit debt obligations of Australian ADIs
and foreign subsidiary banks operating in Australia.

It will enable Australian institutions to raise funds overseas in
the current tight conditions and will restore confidence in credit
markets. The facility will be withdrawn once market conditions have
normalised. Details will be finalised in the next few days.[5]

The Prime Minister also said:

The Government is making available to Australian-owned banks,
Australian subsidiaries of foreign owned banks, building societies
and credit unions a guarantee on eligible wholesale borrowing.

Funding covered

The guarantee on wholesale borrowing will be made available to
Australian-owned banks, Australian subsidiaries of foreign-owned
banks, building societies, and credit unions. It will be available,
on application, for new and existing term debt issuance out to 5
years (60 months). The guarantee will be available for eligible
debt instruments issued in all major currencies.

The guarantee will not be available to foreign banks, including
those with branches in Australia, or entities that are not
APRA-authorised deposit-taking institutions. These latter entities
are not subject to Australia s prudential regulation regime.

Lenders that are not APRA-regulated will have access to the
Government s complementary initiative to invest an additional $4
billion in residential mortgage-backed securities [6]

However, on 24 October 2008, the Government decided to limit the
scope of the FCS by implementing a fee schedule for guaranteeing
deposits over $A1 million (that is, for large deposits ).
Consequently, the wholesale funding guarantee was expanded to
include a guarantee for large deposits.

In
announcing the changes to the parameters of the Guarantee
Scheme, and the decision to impose a fee for guaranteeing large
deposits, the Treasurer, the Hon Wayne Swan MP said:

Today the Prime Minister and I received advice from the Council
of Financial Regulators and, based on the Council s
recommendations, the Government has decided that a threshold of $1
million be implemented, over which a fee will be charged to receive
the benefits of the deposit guarantee.

This fee will ensure the deposit and wholesale funding
guarantees apply in a consistent manner for larger investments, for
which deposits and securities are interchangeable. In particular,
it will ensure that the deposit guarantee does not provide
disincentives for market participants to operate in short-term
money markets.

The fee will apply from 28 November 2008. Up until that date all
deposits and wholesale funding eligible for the guarantee
arrangements will be guaranteed without charge. After that date,
deposits over $1 million and wholesale funding will only be
guaranteed if the relevant fee is paid.[7]

In a press release dated 25 November 2008, the Australian
Bankers Association said:

The Australian Bankers Association welcomes the introduction of
Commonwealth legislation supporting the Government s guarantee
scheme for large deposits and wholesale funding.[8]

Particularly, David Bell, Chief Executive of the Australian
Bankers Association, said:

The legislation authorises the Government to make payments
against its guarantee scheme. While there is no evidence any bank
depositors or investors will need to call on the guarantee scheme,
the legislation removes potential uncertainty around the timeliness
of payment in the event of a claim.

It is important the legislation is passed quickly, avoiding delay
to the guarantee scheme s scheduled commencement on Friday (28
November 2008). Speed of passage through Parliament is a priority
for banks.[9]

The group that represents credit unions and mutual building
societies in Australia, Abacus Australian Mutuals, also welcomed
the Guarantee Scheme:

Credit unions and mutual building societies have welcomed the
move by the Government today to continue its guarantee of credit
union, bank and building society retail deposits.[10]

However, the Chief Executive Officer of Abacus Australian
Mutuals, Louise Petschler, has expressed some reservations about
the Scheme:

While this retail deposit threshold covers the vast majority of
household deposits in Australia, we think there are some issues
with the model

All regulated banking institutions - Australian banks, building
societies and credit unions - meet the same regulatory requirements
under APRA [the Australian Prudential Regulation Authority, which
already regulates those financial institutions eligible to
participate in the Guarantee Scheme]. In our view, regulation by
APRA offers far better protection than the now frequently
criticised international debt rating agencies

Those ratings are not relevant for most mutual banking
institutions as we do not need to raise debt funding in wholesale
markets

It s ironic that the safe, mutual part of the banking system, which
is not exposed to wholesale market turmoil, looks likely to be
charged more than those who are in these markets.[11]

(Note that these comments were made after the release of the
operational and design parameters by the Treasurer on 24 October
2008 but prior to the decision by the Government to introduce the
Bill.)

The Senate s Selection of Bills Committee met privately on
Wednesday, 26 November 2008. It considered a proposal to refer the
Bill to the Senate Standing Committee on Economics, but was unable
to reach agreement on whether the Bill should be referred.[12] In the event, the
referral became irrelevant when the Bill was read a third time in
the Senate later that day.[13]

Several members of the Opposition initially criticised the
Guarantee Scheme (particularly the way the Government handled its
implementation) but supported the passage of the Bill. For example,
the Shadow Treasurer, the Hon Julie Bishop MP, in a second reading
speech on an unrelated Bill, made the following comments on 25
November 2008:

It has been obvious from the day of its announcement that the
consequences of the bank guarantees had not been fully thought
through. The consequences might have been unintended but they were
certainly foreseeable. Rather, as is typical with the Rudd
government, the bank guarantees were from the first all about a
political strategy, with no regard for sound economic management.
Since the announcement of the bank guarantee policy, the government
have been continually playing catch-up to correct a series of
unintended but largely foreseeable difficulties arising from their
hasty actions. It is for this reason that we will be debating yet
another bill later this afternoon, which has been introduced at
great haste with little information to provide an appropriations
framework for the guarantees.

All these government initiatives have been conspicuous by the
absence of rigorous analysis and the coalition is concerned that
the same poor approach to public policy will occur with the
significant amounts of public money in these three funds. The lack
of analysis underpinning a range of government decisions, including
the recent economic stimulus, raises concerns that the government
will choose projects with little regard to their long-term
benefits. These recent government decisions, including the decision
to spend half the budget surplus in one hit but without any
modelling or research, as Treasury admitted in Senate estimates,
have had little analysis. There has been nothing public and there
is nothing to show that they will achieve the desired
result.[14]

In the event, the Bill was read a third time in the House of
Representatives later that day.[15]

On the issue of the Opposition s refusal to agree to the
referral of the Bill to the Senate Standing Committee on Economics,
and also on the issue of the Opposition s support for the Bill,
Senator Helen Coonan said:

We will be supporting the bill not because we in any way commend
the government for the way in which this has been handled but
because we accept that all of this delay is causing ongoing
uncertainty for financial institutions, for consumers and for the
economy more broadly. We accept that this matter should be dealt
with urgently and expeditiously. It is why we are responding to the
government s request that we deal with it without reference to a
committee. Whilst I have a degree of sympathy for Senator Brown s
natural curiosity as to how this appalling situation could come
about, it is important that I place on the record the opposition s
reasons for opposing it being sent to a committee.[16]

On 26 November 2008, Senator Bob Brown expressed serious
reservations about the speed with which the Bill was passing
through Parliament, particularly as the Government had earlier
denied the need for any legislation to implement the Guarantee
Scheme. He moved unsuccessfully for the Bill to be referred to the
Senate Economics Committee (see above). Senator Brown particularly
emphasised the need for scrutiny of the Bill, given that, in his
words:

it is simply a means of the government guaranteeing the banks
when they borrow overseas and, on the long-shot chance that one of
those borrowings fail, the public picks up the tab. When the public
picks up the tab, that means money that otherwise might be
available under consolidated revenue or through borrowings for
hospitals, for schools, for public transport, for security, for the
environment or for tackling climate change will instead go to make
up for that defaulting bank loan which means the defaulting bank.
This is legislation which, logically, will encourage more risky
borrowing overseas. It is legislation which will increase borrowing
overseas and therefore, logically, the potential for default.

This is socialising the risk of the big banks. It is as simple as
that. And it deserved much more scrutiny than we are getting here
today.[17]

Senator Bob Brown then moved two amendments to the Bill: the
first would insert a sunset clause (to the effect that the Act
should cease to have effect two years after its commencement), and
the second would require the Minister to make a statement to
Parliament about any borrowings under proposed subsection
6(1) (see Main Provisions section below). Neither motion
to amend was successful.[18]

The benefits of a large deposit guarantee scheme are derived
through increased confidence amongst depositors in the ADIs
participating in the scheme. This reduces the probability of a run
by depositors on an ADI (or ADIs). The extent of this increased
confidence is not quantifiable. In an environment where governments
around the world were introducing or expanding deposit insurance
arrangements in their own countries (as was the case around the
beginning of October 2008), Australian financial institutions could
have been disadvantaged in obtaining funds from overseas if the
Australian Government had not intervened to protect them (although
how badly is not known). Thus, some level of deposit insurance and
wholesale funding guarantee was necessary to ensure Australian
financial institutions were not at a competitive disadvantage in
relation to foreign competitors.

There are also significant costs in taking such an approach. As
the guarantee scheme is limited to deposits , investments which are
at least to some degree, substitutable for ADI deposits may be
considered, in the presence of a deposit guarantee, to be less
attractive to investors. This can (and arguably has) led to or
worsened a run on some of these deposit substitutes . This can also
make it difficult for other non-financial firms (i.e. any firms
that are not involved in the financial sector) to issue new
debt.

In addition, the provision of a guarantee or insurance against
losses (in a wide range of situations) can induce market
participants to act in a more risky fashion than they otherwise
would. This is known as moral hazard .[19] In practical terms, the Government
has essentially allowed ADIs to piggy back off Australia s
sovereign credit rating. This means that ADIs will find it easier
and cheaper to obtain funds. Also, in knowing that the Government
will meet their liabilities in the event of the ADI s own failure,
or the liabilities of failed counter-parties (in the case of
wholesale borrowing), ADIs could lend in a less responsible
fashion. The costs of moral hazard as a result of the Guarantee are
also unquantifiable.

Expenditure only arises if an institution is unable to meet its
obligations under the Guarantee. As stated in the Explanatory
Memorandum for the Bill:

the Government is likely to be able to recover any such
expenditure through a claim on the relevant institution. The impact
on the Government s budget would depend on the extent of the
institution s default and its ability to meet the Government s
claim.[20]

The Senate Standing Committee for the Scrutiny of Bills
commented on this issue in the context of clause 5
of the Bill (see quote from the Committee s report in the Main
Provisions section below).

Clause 3 of the Bill defines the terms Deed of
Guarantee and Scheme Rules . The term Deed of Guarantee is defined
as being the Deed of Guarantee in respect of the Australian
Government Guarantee Scheme for Large Deposits and Wholesale
Funding executed on 20 November 2008, as that Deed is in force from
time to time , and Scheme Rules is defined as the Rules identified
in the Deed.[21]
The Scheme Rules are identified in the Deed of Guarantee as being
those published on the website www.guaranteescheme.gov.au.[22] The Deed of Guarantee and
associated Scheme Rules were executed by the Treasurer on 20
November 2008.[23]
Neither document is a legislative instrument that is subject to
disallowance by either House of Parliament.

Clause 4 states that the Act applies both
within and outside Australia , which means that payments may be
made to persons inside or outside Australia, and that moneys
borrowed to repay claims under Clause 6 of the Bill may be borrowed
from inside or outside Australia.

Clause 5 provides a standing appropriation from
the CRF for the dual purposes of paying claims under the Deed of
Guarantee and repaying any borrowing (and interest due on any
borrowing) under proposed section 6.

In relation to clause 5, the Senate Standing
Committee for the Scrutiny of Bills made the following
comments:

The Committee has determined that, as part of its standard
procedures for reporting on bills, it should draw Senators
attention to the presence in bills of standing appropriations. It
will do so under provisions 1(a)(iv) and (v) of its terms of
reference, which require the Committee to report on whether
bills:

In scrutinising standing appropriations, the Committee looks to
the explanatory memorandum for an explanation of the reason for the
standing appropriation. In addition, the Committee likes to
see:

some limitation placed on the amount of funds that may be so
appropriated; and

a sunset clause that ensures the appropriation cannot continue
indefinitely without any further reference to the Parliament.

In this case, clause 5 limits the purpose for which the
appropriated funds can be used and the Treasurer, in his second
reading speech, noted that the appropriation is necessary to cover
the very unlikely event of a claim on Government under the
guarantee . Further, the bill will ensure that, from 28 November
2008, any claim under the Guarantee Scheme, however unlikely, will
be able to be paid in a timely way .

In addition, and in line with its comments in relation to the
Financial System Legislation Amendment (Financial Claims Scheme
and Other Measures) Act 2008 in Alert Digest No. 12
of 2008, the Committee is mindful of the backdrop of economic
uncertainty against which this standing appropriation is considered
necessary. The Committee also notes that the standing appropriation
has already been agreed to by both Houses of Parliament and is, in
any case, designed to counteract exceptional circumstances (should
they arise).

In the circumstances, the Committee makes no further comment on
this provision.[24]

Clause 6 deals with borrowing. Proposed
section 6 contains a discretionary power that will be
required if there are insufficient funds in the CRF to pay claims
at the time the claims are to be paid. The Minister (which term is
not defined in the Act but presumably, applying section 19A of the
Acts Interpretation Act 1901 (Cth), means the Treasurer,
or Minister for Finance, or some other Minister having
responsibility for Commonwealth financial matters) may borrow money
on behalf of the Commonwealth for the purpose of paying claims
under the Deed of Guarantee, but the borrowing period must not
exceed 24 months: proposed subsections 6(1) and
(2). Borrowing includes raising money or obtaining credit,
whether by dealing in securities or otherwise: proposed
subsection 6(3).

Concluding comments

The Bill is part of the Government s response to the global
financial crisis and is intended to encourage confidence in the
Australian financial system by guaranteeing large investments and
wholesale funding in Australian incorporated banks and ADIs.

There was much criticism from the Opposition about the timing
and details of the Guarantee Scheme, but ultimately the Bill was
read a third time in each house on the same day as it was
introduced.

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